Euro gains most in six months as Hawks help cool dollar fever

(Bloomberg) — The euro rose the most in six months after European Central Bank policymakers said further interest rate hikes may be needed and as traders bet U.S. inflation data more late this week could undermine the need for aggressive tightening in the US.

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The common currency rose as much as 1.6% to $1.0198, its biggest gain since March. Bundesbank President Joachim Nagel said the central bank should take further clear steps if the inflation picture remains the same. The ECB raised its key interest rate by an unprecedented 75 basis points last week to curb the fastest rate of consumer price growth on record, narrowing the interest rate gap with the Federal Reserve.

The moves came amid broad-based dollar weakness, with Bloomberg’s gauge of the greenback’s strength falling to its weakest level in nearly two weeks and extending a retreat from a record high reached earlier this month. U.S. CPI data for August is expected to show a slowdown in price growth, according to a Bloomberg survey of economists.

The market was decidedly bearish on the outlook for the euro as Russia continues to curb gas supplies to the region, stoking inflation and raising the prospect of a recession. The ECB lagged behind the Federal Reserve in tightening policy against a background that helped the euro fall to a two-decade low this year. Investors have been so short the common currency only five times over the past two decades, according to custody data from Bank of New York Mellon.

“To justify clients adding to these shorts, we have to say the euro is facing existential problems or the financial system is facing systemic risks.” Neither is a reasonable assessment of the current predicament in the eurozone,” said Jeffrey Yu, senior strategist at the bank. “The weight of the correction is clearly towards offloading euro short positions.”

The euro also extended gains against the pound, rising at one point to its highest since February 2021 at 87.22 pence. Monday’s move caught traders off guard, triggering stop losses and complicating the common currency’s progress, according to two Europe-based traders.

The euro could also find a firmer footing with a focus on ECB Executive Board member Isabelle Schnabel’s speech. Reports of an unexpected breakthrough by Ukrainian forces in the war against Russia also helped boost sentiment on the euro.

“We are clearly in a mini-correction phase for the dollar at the moment, largely driven by a recovery in risk sentiment and some unwinding of stretched long dollar positions,” said Francesco Pezzole, currency strategist at ING Groep NV.

(Adds context throughout. A previous version of this story corrected the size and scope of the euro increase in the headline and margin.)

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